By Natalie Hayes Schmook, MBA, CFP, CVA
The number one question I get regarding saving for retirement is: How much is enough?
As a financial advisor, I use a sophisticated process called a Monte Carlo analysis to help determine how much a doctor needs to be saving for retirement given their age, annual spending, assets, cash flow and other considerations.
There’s good news if you don’t have access to financial planning software. There’s an easier way to calculate retirement that almost always works: the 4% rule.
THE 4% RULE
The 4% rule says this: the amount you need to retire is equal to your annual spending as calculated in last month’s tip divided by 4 percent. Let’s look at an example: if your personal spending rate in retirement is $100,000 per year, the 4% rule says you will need about $2,500,000 to retire. ($100,000 ÷0.04)
As a history lesson, 4 percent has been considered to be a sustainable distribution rate (how much you can take out) for an investment portfolio that holds mostly stocks. So for a $1,000,000 portfolio, an investor could reasonably withdraw $40,000 per year and have that portfolio stay intact through retirement.
Now you might be thinking that you expect your stock portfolio to produce 8 percent per year, so the 4 percent calculation seems low. Maybe so, but consider these points:
- That 8 percent expected return is a pre-tax number. Investors will owe taxes on dividends and capital gains in taxable portfolios and owe ordinary income (paycheck taxes) in most retirement accounts. This is one exception to the 4% rule: if all of your retirement savings are in a 401k, traditional IRA or Simple IRA, 4% might be too high of a withdrawal rate after taxes.
- On average you might expect your portfolio to produce 8 percent per year, but stocks can and will have negative returns for a year–or years–and pulling more than 4 percent out of a portfolio in down years can be detrimental to the portfolio principal and leave less to grow over time.
- The 4% guidance leaves a buffer for inflation by leaving some of the expected annual return in the portfolio, where it is able to grow more than the initial amount.
I do encourage ODs to do a Monte Carlo analysis, especially as they get into their 40s, but for younger doctors or those just wanting to see if they are on track, the 4% rule is a great start.
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